Past is Prologue: A New Approach to Cross-Border Application of Dodd-Frank Swaps Provisions

On September 4, 2018, in a speech to the City Guildhall in London, Chairman Giancarlo previewed a new approach to cross-border application of Dodd-Frank swaps provisions, which will be memorialized in a forthcoming white paper.

Chairman Giancarlo began his remarks with a historical overview of cross-border swaps regulation, highlighting post Dodd-Frank reforms. He then summarized the current regulatory regime, emphasizing the substantial progress that has been made in the world’s primary swaps trading jurisdictions to implement commitments made after the 2008 financial crisis at the Pittsburgh G-20 summit.

The Chairman went on to offer a mea culpa and an apologia, stating that the CFTC’s current approach to applying swaps rules to its cross-border activities has resulted in a number of problems. The Mea culpa was offered for the 2013 cross-border guidance which imposed CFTC transaction rules on swaps traded by U.S. persons even in jurisdictions committed to G-20 swaps reforms. Chairman Giancarlo expressed his view that such an approach“alienated many overseas regulatory counterparts and squandered important American leadership and influence in global reform efforts.” The Chairman allowed that CFTC’s “over-expansive assertion of jurisdiction” may have been understandable in 2013 when other G-20 jurisdictions had not yet implemented swaps reforms. However, today, he views the approach as increasingly out of sync with the world’s major swaps trading regimes, which have since adopted comparable swaps reforms.

The Chairman then proceeded to outline his vision for what he titled “Cross-Border Swaps Regulatory Version 2.0,” the goal of which would be cross-border rules that are “better calibrated to address systemic risk while fostering innovation, competition and international cooperation.” The new regulatory framework would “enhance market durability, increase trading liquidity and stimulate broad-based economic growth and revival.” The Chairman also stated that the Commission should adopt final cross-border rules rather than “rely on less clear cut interpretive policy statements or guidance.”

Accordingly, the Chairman stated that he intends to direct the CFTC to develop proposed rules governing the cross-border application of the swaps provision of Title VII of the Dodd-Frank Act. The rules would be informed by the past four years of experiences and global implementation of swaps reform as well as the swaps trading data collected by the CFTC. The goal of the proposals would be to address systemic risk to the U.S. financial system but tailored to the market as it exists now, as opposed to how it existed in 2010 or even 2013.

Chairman Giancarlo then set out the five principles that will be used to inform the revision of the CFTC’s swaps rules for cross-border activities.

First Principle: A focus on systemic cross border risk as opposed to local trading rules. “The CFTC should recognize the distinction between swaps reform intended to mitigate cross border systemic risk and reforms designed to address particular market and trading practices that are suitable for tailoring to jurisdictional trading conditions.” To illustrate the difference between rules to address systemic risk and trading practices Chairman Giancarlo referred to the request for quote mechanism on trading venues stating, “whether or not a U.S. trading venue has functionality that requires a request for quote for three dealers (RFQ-to-3) or ten dealers has almost nothing to do with the transference of counterparty risk to the U.S. financial system.” The Chairman would characterize RFQ-to-3 as a reform to address trading practices and therefore suitable for tailoring to specific jurisdictions and their particular conditions.

Second Principle: Multilateralism to mitigate systemic risk. “The CFTC should pursue multilateralism, not unilateralism, for swaps reforms that are designed to mitigate systemic risk.” Chairman Giancarlo believes the CFTC should “seek a reasonably strong degree of comparability with global standards and laws of G-20 regulators.” Ultimately, “systemic risk mitigation reforms should be appropriately comparable across borders to mitigate risk of cross-border contagion.” Nevertheless, the CFTC should “operate on the basis of comity, not uniformity, with non-U.S. regulators that oversee comparable regulatory regimes.” Otherwise the alternative is a “world in which every regulator asserts global jurisdiction over swaps trading abroad by their home domiciled institutions, leading to a completely untenable state of overlapping and duplicative regulations and highly fragmented trading markets.”

Third Principle: A rule maker with one rule set. “The CFTC shall be a rule maker, not a rule taker, in overseeing U.S. markets – one marketplace, one set of trading rules.” Perhaps as a rebuke to the on-going EU-U.S. struggles over central counterparty (CCP) (i.e., clearinghouse) regulation, Chairman Giancarlo emphasized the size and importance of U.S. derivatives markets and went on to stress, “the CFTC has every right to expect that non-U.S. regulators defer to it on oversight of U.S. derivatives trading markets, as the CFTC should defer to non-U.S. regulators for activities conducted primarily in their jurisdictions, and it should seek to reconcile its rules with rules adopted by its non-U.S. regulatory counterparts, as appropriate.”

Fourth Principle: An aggregated approach to deference . “The CFTC should act with deference towards comparable swaps reform regulation in non-U.S. markets adopting a flexible, outcomes-based approach for substituted compliance.” Chairman Giancarlo raised concerns with the CFTC’s current regime of substituted compliance and proposed instead: “the CFTC should focus on whether a non-U.S. regulators regime, in the aggregate, provides a sufficient level of regulation to justify a comparability assessment.”

Fifth Principle: A global advocate for comparability. “The CFTC should act to encourage adoption of comparable swaps reform regulation in non-U.S. markets that have not yet adopted swaps reform for any significant swaps trading activity.” With respect to non-U.S. jurisdictions that do not yet have comparable requirements to the CFTC’s and generally have not implemented the swaps reforms agreed to by the G-20 leaders in Pittsburgh in 2008, U.S. rules should apply to U.S.-related entities rather than taking a deferential approach.

The Chairman closed his remarks by offering a few concrete recommendations, which will be included in his forthcoming white paper. The recommendations pertained to non-U.S. central counterparties, non-U.S. trading venues and non-U.S. swap dealers and focused on easing the regulatory burden on each such entity.

Covington’s Futures and Derivatives practice routinely assists clients in the navigation of the regulatory, compliance and operational challenges posed by the cross-border approach of the CFTC. We will provide an update on the white paper when it is released.

Chairman Giancarlo has long argued that the CFTC’s current cross-border approach, which emphasizes “identical, rule-by-rule substituted compliance analysis,” is inconsistent with the approach agreed upon by G-20, which urged a commitment to “consistent” rather than “identical” implementation. The speech delivered last week underscores that view and lays out a vision for cross-border swaps regulation that reflects a less stringent, or identical approach.

It is important to note that the white paper will only provide Chairman Giancarlo’s view of a new cross-border approach. This white paper will need to be transposed into a proposed rule for a full Commission vote and public comment before there can be any changes to the CFTC’s current cross-border construct. With new Commissioners on board, who will need time to get up to speed on the substance of the Chairman’s agenda, the timing of the changes Chairman Giancarlo has discussed will not be seen until next year.